Most financial planners use some version of age based investment strategy. Client needs are different. The investment strategy for a 30 year old will be different than those of a 70 year old. The reasons are simple. An older person has less time to make up losses than a younger person. The older the investor, the less risk that investor should take.
A Simple, but Effective Approach
Many financial planners use an asset allocation model known as “Your Age in Bonds.” Very simply, whatever a person’s age is, that is the allocation in they should have in bonds. For example, for a 50-year old investor, the target for bonds and cash would be 50% of the portfolio value. The remainder of the portfolio should be in foreign and domestic stocks. The allocation is reviewed annually and adjustments made as the investor ages.
As simple as this concept is, it may not be practical for every person’s portfolio. Different people have different needs and their chronological age may not be the best way to determine portfolio allocation.
Age Contrasts
Everyone’s needs are different. A 30-year old is typically working, may be investing in the company 401(k) and has minimum saving. Market gyrations will have little impact on their net worth. They have many years of working and many opportunities to build a savings. So a 70/30 allocation in stocks and bonds would be a good start.
There is no such thing as a typical 55-year old investor. Some have accumulated significant wealth while other have few asset and significant debts. Some have 401(k)s, other’s have pension plans and some are relying on their own saving for retirement.
Family status is diversified also. Some have small families, no family or a large extended family. Some may have aging parent. While the “Your Age in Bonds” is a good asset allocation model, it cannot be applied to every investor.
Rather than use an investor’s chronological age as the primary yardstick, it makes more sense to use the investor’s allocation age to guide asset allocation. A person’s allocation age may be higher or lower than their chronological age. The allocation age takes individual life situations into account.
An example: Say a 65-year old couple has accumulated $2 million in liquid assets. They have two grown children who do not need financial support. The couple spends about $100,000 a year of which about $60,000 comes from pensions and social security. The balance of $40,000 comes from their savings account. A 35/65 stock/bond allocation would not be appropriate for this couple.
One approach would be to divide their assets into two portfolios. One portfolio of $1 million would be 35/65 stocks/bonds mix allocated to meet the income needs of the couple. The remaining $1 million is not likely to be needed by the couple and will pass to their children. So the second portfolio should be asset allocated to match their children’s age. Their average age is 35 so an appropriate allocation for this portfolio would be 65/35 which is the recipient’s allocation age. Instead of splitting the portfolio, the $2 million portfolio could be asset allocated as a 50/50 mix of stocks/bonds which is the couple’s asset allocation age.
Tale of Two Women
Assume a 55-year old woman is barely getting by. She has a small amount in her 401(k), has some housing debt and is caring for her aging parents. This person would have an asset allocation age of about 70 because she has a high cash flow risk. She is financially vulnerable and cannot afford to lose any sizable amount of her savings.
A second 55-year old woman has a pension plan, no housing debt and a large Roth account. Plus she expects to inherit a sizable estate from her parents. Her allocation age would be about 40 as she has no cash flow risk and no foreseen liabilities.
Two women, same age, but at vastly different asset allocation ages. The first woman should have at least 70% in bonds due to her financial situation. The second woman may have 60% in stocks and 40% in bonds because she is in much better financial shape and can tolerate more risk.
Chorological age is a good place to start with asset allocation. But the ultimate asset allocation is based on your asset allocation age which may higher, or lower than your chorological age.
David Snellen
Registered Investment Advisor
USA Living Financial Group
954-302-3628
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